Great Opportunity – Costly Blunder #2

One challenge that is not of mythical proportions is: ’cash flow is king’!

Businesses (both large and small), as well as nations, often fail financially because they cannot support the debt they have accumulated – often accumulated over a short period in tough times.

When the chariot is racing around the coliseum and the crowd is hooting and hollering, despite the wobbly wheel about to fall off the hub, the driver prays and hopes for the best in his drive to the finish line – and the bag of coin.

Hope is not a strategy!

Firms face the highest failure risk when they are either young and small – or older and ossified.

Failure flows from the inability to generate self-sustaining levels of operating capital.

Yet, as the wheel is about to finally buckle, hope that all will be well still drives us on!

Much of the research suggests management inexperience and incompetence is the most consistent cause of business failure. We disagree with this simplistic view because it ignores the reality that both internal – and external – factors are often at play – and the initial strategic reason for creating the venture is not recognised. Businesses are created for a multiplicity and, often contradictory reasons, such as, for profit, for capital gains, for self-employment or simply for social benefit.

Sixty-three per cent of American adults over 50 and 46% in Britain plan to work in retirement for personal fulfilment or for the need to generate an income. At this age many have accumulated a financial nest egg, but the kicker is; drawing down that nest egg provides start-up capital but at the same time diminishes the capital available for retirement. Thus, the business has to be cash-flow positive – or eventual retirement can be bleak! Conversely, success can be the icing on the cake!

Exogenous shocks like cancelled contracts (not caused by the business owner), economic downturn and new entrants into the market are all outside the owner’s control. Yet responsibility for the downfall due to these factors is often assigned to the owner in the research models.

How does the following piece of research resonate in your mind?

In the midst of the most devastating global economic depression ever recorded, Cover (1933) is reported to have concluded that the major cause of retail bankruptcy was due to ‘discernible errors in management‘.

Banks closed, personal and business deposits disappeared, loans dried up, and retail consumption collapsed: all because of “…discernible errors in retail management…”.

What absolute nonsense!

Needless to say, new firms must establish sustainable cash flows before initial funds are depleted. And, older firms need to ensure that resources and capabilities continue to create value as competition escalates.

But how?

Keep the customer interested by regularly renovating your product/service offering, innovate faster than your competitor(s) and, ensure your enterprise is sufficiently agile to shift gears at short notice!

And, buy long and sell short!

A former colleague revelled in narrating the story of the creation and growth of what eventually became the multi-million dollar family business. It was financed via a 180 day payment scheme of arrangement with offshore suppliers – and product sold on C.O.D!

In effect, the supplier financed this business.

Some years past a highly successful entrepreneur was quoted as follows: “If I have a $1m debt with my bank, I have a problem. If I have a $10m debt, they have a problem!

Note, we are not espousing this approach in dealing with one’s bank!

Some research suggests that 75% of firms fail due to poor financial planning, but that is like saying the person became unconscious by not breathing: that may be literally true, but the causes could be many! Thus, we argue that the following arguments are probably more representative of what actually happens:

a)    Bankruptcy is due to either an exogenous shock;  or
b)    The failure to implement a timely exit strategy!

We add in response to old the adage: “..…when the going gets tough, the tough get going..” “…and the smart ones ‘get out’ (before bankruptcy)!”

Poor cash management is undoubtedly the death knell to all enterprises, but the cause is not as simple as some research suggests – it is also (at least in part) as a consequence of uncontrollable events.

Needless to say, business is about assuming the throne as the cash flow king, or the pauper prince!

And, when is the best time to ‘pull the plug’ on the enterprise?

Remember that wobbly wheel, it only has to hang on for another lap (i.e., the next deal) – and the bag of coin is in hand! Well, maybe!

8 thoughts on “Great Opportunity – Costly Blunder #2

  • Nat,
    Thanks for the feedback.
    Loved your humour. I think you hit it in one!

    Comment from: Strategic Outcomes

  • Thank you for your blog. I always have a dictionary handy when I read your articles. I always laugh when I read ‘the latest research’ and ‘analysts reports’. One has a strong buy recommendation, while another has a hold, and very few have a sell? Of course the smart people of the day would have said ‘discernible errors in management‘. They probably never ever has their own business.

    Comment from: Nat

  • Marion,
    In my mind, there is a mad rush toward ‘Me Too’ products/services and strategies to operate against. I call it the ‘Lemming’ strategy – all heading toward the cliff in unison – an all too common practice!

    The first thing I look for is the ‘Saw-tooth effect’, that is, the coherence (or not) of the up and down fluctuations of the metrics in strategic decisions across Finance, Marketing, Operations and HR divisions of the business. These must firstly be aligned with the overall strategy and in a coherent and synchronised manner. And, where a metric ‘zigs’ and the direct correlate ‘zags’ out of unison, then someone has not done their modelling!

    To me, a substantial increase in short and long-term debt is not a major problem in and of itself (particularly in tough economic times) – as long as it is sustainable – and there is capacity to repay it on call. It becomes a problem when that debt is not used to enhance the efficiency of the business through innovation to (sooner rather than later) generate significantly increased profits above and beyond organic growth.
    Hope this answers your question

    Comment from: Strategic Outcomes

  • It seems to me that more and more businesses are losing their strategic competitive advantage. They are becoming more and more commodity based, making them extremely unattractive to potential buyers. It is important to identify whether your business is heading towards the edge of the cliff ever so slowly. What financial metrics would you look at that demonstrate signs of an incompetent management? I know that an obvious one may be substantial increases in short term and long term debt.

    Comment from: Marion H

  • Steph,
    In my mind, best to listen to the optimist and realist in equal parts. Maybe Leonard Louis Levinson put it somewhat more poetically: A pessimist sees only the dark side of the clouds, and mopes: a philosopher sees both sides, and shrugs; an optimist doesn’t see the clouds at all – she’s walking on them.
    I have long-held the belief that one should listen to their ‘gastric juices’ in business decisions, as when they are ‘a bubbling’ they’re telling you something far more important than the wisest of counsel! Knowing what they are telling you – now that’s a skill to behold – and a work in progress for me.

    Comment from: Strategic Outcomes

  • Who should we listen to in ourselves regarding our business? The optimist, the pessimist or the realist . This characteristic in myself forces me to look for a silver lining in every dark cloud 🙁

    Comment from: steph

  • Kevin,
    Cash flow (i.e., total net cash flow): The positive or negative cash balance over a given period of time (i.e., 4, 6, 8 or 12 months). Positive = more; Negative = less. Total net cash flow is: Operational cash flows (e.g., cash received or increased as a result of internal business activities often referred to as working capital). Investment cash flows: monies expended (e.g. investments, acquisitions and long-life assets) or monies received from the sale of long-life assets. Financing cash flows: Cash received via issuing debt and equity, or payment of dividends, share repurchases or repayment of loans/debts.
    Free Cash Flow: Operating cash flow minus capital expenditures (i.e., the cash a company generates after expending the money required to maintain or expand the asset base) calculated by taking operating cash flow minus capital expenditures. Or calculated as: EBIT(1-Tax Rate) + Depreciation and Amortization (i.e., Change in Net Working Capital – Capital Expenditure) and believed to better indicate ‘real’ capacity to generate cash and profits!
    My response is with a little help from a finance friend, but hope this helps.

    Comment from: Strategic Outcomes

  • There has been much written about cash flow and free cash flow, can you explain the difference?

    Comment from: Kevin

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